As the year begins, many employees focus on receiving feedback about their previous year’s performance and setting objectives for the upcoming year. But one of the most sensitive and important questions often arises: What will be my salary increase? While this question is crucial for many, the topic of pay can be delicate for both employees and organizations. Interestingly, in some industries, it’s sometimes overlooked that personnel costs are just a small fraction of the total operating costs of a business. Despite this, salary increases remain a central topic during performance reviews.
Is pay philosophy clear in organizations?
It’s no secret that organizations often do not clearly communicate their approach to compensation, leading to unrealistic expectations from employees. Many workers assume that a salary increase is a given, but that’s not always the case. In some companies, salary increases happen automatically each year, regardless of the company’s performance, because the decision is made at an industry-wide level. This could be due to a collective bargaining agreement or other top-level decisions that apply uniformly to all employees in that sector.
However, this practice can create a disconnect. Employees in such companies may receive increases without their individual performance being evaluated, which can sometimes lead to complacency. On the flip side, high performers might feel undervalued if they don’t receive recognition commensurate with their efforts.
Pay philosophy influences Company Culture and Employee Behaviour
An organization’s pay philosophy is often shaped by the CEO, with the support of the CHRO and CFO, and endorsed by the board through a Remuneration Committee (Remco). In smaller companies, the CEO alone may have the final say. This philosophy plays a significant role in defining the culture of the company and the behaviours it wants to encourage. For example, does the company place greater value on individual performance and reward top achievers, or does it focus on recognizing team success?
Pay philosophies are often formalized in a Compensation & Benefits (C&B) Framework, which sets clear rules for how salary increases should be distributed. These frameworks provide transparency, ensuring that employees understand the criteria for raises and bonuses, and help to align compensation with company values and objectives.
Why Salary Increases Matter ?
A salary increase is not just a financial boost for employees; it carries deeper implications for the company. Here’s why it’s essential to recognize employees with pay raises:
- Motivation and Appreciation: A salary increase is a tangible sign of appreciation, boosting employee morale and encouraging them to maintain or improve their performance.
- Retention of Talent: Offering competitive salaries helps retain top performers, reducing the risk of losing them to competitors offering better pay. This is particularly important in industries facing high turnover or skill shortages.
- Incentivizing Better Performance: A well-structured pay increase system incentivizes employees to contribute at their highest level, driving both individual and organizational success.
- Attracting Talent: Regular salary adjustments keep your pay competitive, making the company attractive to top talent in the job market. Employees often compare their salaries with peers, and a company that lags behind can quickly lose its best people.
- Boosting Employee Morale: Pay increases help foster a positive work culture, improving the overall atmosphere and satisfaction among employees.
- Enhancing Employer Reputation: Organizations that offer fair and competitive compensation are seen as more reputable, which can help attract better candidates and improve employee loyalty.
How to Define a Salary Increase: Technical Aspects
In my view, a salary increase should be a combination of two key factors however based on experiences, i saw some organizations who are only considering inflation setting accordingly their increase budget :
- Inflation Adjustment: Employees need to see their salaries adjusted to keep up with inflation. This ensures that their purchasing power is not diminished by rising costs of living. For example, in regions with high inflation rates, an annual increase may be necessary just to maintain an employee’s real income. Such an approach does not allow any correction for employees being under paid for whatever legacy reasons.
- Merit Recognition: A salary increase should also reward those who have contributed significantly to the company’s success. This recognizes the value an employee has added, based on their performance and impact. The increase should reflect the individual’s market value relative to their performance.
Companies that align salary increases with both internal performance and external market trends are more likely to maintain competitiveness while still paying highest attention to internal equity.
Market Benchmarking: The Role of External Data
One of the most technical aspects of salary increases is benchmarking salaries against external market data. Companies need to ensure that their compensation packages are competitive and aligned with industry standards. This is where market benchmarking comes in.
- Market Benchmarking: This involves comparing an organization’s pay structure to that of other companies in the same industry or geographical area. Compensation surveys conducted by firms like Mercer, Aon, or Willis Towers Watson can provide valuable data about salary trends, including base pay, bonuses, and benefits for various roles. Organizations can use this data to assess whether their pay is competitive or if adjustments are needed to attract or retain talent.
- Market Positioning: When defining salary increases, companies must also consider where they stand in the competitive market. Are they positioning themselves as a “market leader,” paying above the median rate? Or are they a “market follower,” paying near or below the median? Understanding this positioning helps align internal compensation strategies with the company’s goals, whether it’s maintaining cost competitiveness or aiming to attract top-tier talent.
- Geographic and Industry Variations: Compensation can also vary significantly by region and industry. For example, salaries for the same role may be higher in urban areas with a high cost of living or in sectors with high demand for specialized skills (like tech or finance). By utilizing compensation data specific to their industry and region, companies can make sure they are staying competitive without overpaying.
Should Everyone Receive a Salary Increase Every Year?
My answer is: no—but it requires context.
While it’s important that every employee receives some form of recognition for their work, a blanket salary increase for everyone may not always be appropriate. The following External factors should be considered beyond the pure internal equity.
- Market Conditions: An employee’s compensation should be aligned with the industry standards and market rates. If someone is already earning above the market rate and performing well, it might make more sense to offer alternative forms of recognition such as a bonus, a larger variable pay, or added benefits rather than an increase in base salary.
- Performance-Based Adjustments: Employees who have not met their objectives or are underperforming may not receive an increase in salary. In these cases, it’s essential that there is clear communication about why the increase isn’t happening, so the employee understands their standing.
The keys to handling salary increases responsibly are communication and courage. I did tackle those topics already in other blogs. Leaders must ensure that employees are well-informed about why they are or are not receiving a raise. This transparency fosters trust and helps employees understand their role within the organization.
Business Performance and Salary Increases
In addition to individual performance, company-wide performance plays a critical role in determining salary increases. When a company has met or exceeded its financial targets, it’s easier to justify salary increases. However, what happens when a company fails to meet its targets?
It might seem logical to withhold raises if the company misses its goals, but this approach may not always be the most effective. A “one-size-fits-all” policy may backfire, especially if it negatively impacts key employees who have contributed significantly to the company’s success at their level.
During tough times, leaders who have the highest accountability should face consequences, but those who have played a critical role in executing the company’s strategy should still be recognized. This balance is crucial for employee retention and maintaining morale.
The Role of HR in Salary Decisions
The HR function plays an essential role in ensuring that salary decisions are fair, balanced, and aligned with both business performance and employee contributions. While it might be tempting for companies to reduce costs by cutting back on pay increases during tough times, this approach can be damaging in the long run. Employees are the driving force of any organization, and cutting back on their compensation can ultimately harm the business.
HR professionals also help to ensure that internal equity (fairness across roles) is maintained alongside external competitiveness (how the company compares to the market). They play a pivotal role in guiding leadership through decisions on pay increases, taking into account both financial constraints and employee expectations.
A thoughtful and strategic approach to salary increases, even in challenging times, can reinforce loyalty and strengthen the company’s ability to weather difficult periods.
Conclusion
Salary increases are an essential tool for motivating employees, retaining talent, and maintaining a healthy company culture. While they should not be guaranteed every year for everyone, they should be thoughtfully considered based on both individual performance and overall business health. Companies that foster clear communication, fairness, and a well-structured compensation strategy backed by market data will not only retain top talent but will also create an environment where employees feel valued and invested in the company’s success.
